Inflation, War Spending, and the Federal Reserve’s Shell Game
You’ve been hearing a lot about sound money. Now I’m going to talk about unsound money: especially how it promotes war, and how governments love unsound money largely because they love war.
A great thinker named Randolph Bourne once wrote, “War is the health of the State.” Now what did he mean by that? Well, in times of peace, people are more likely to ignore the government, even stand up to it. Rather than following orders, they’re more interested in leading their own lives; in doing the peaceful, productive things that humans do in a civilization: trading with people, working together, enjoying their free time, getting to know each other, falling in love, etc.
But when people believe there is a great foreign enemy threatening them or holding onto stuff they want, they develop war fever and become obsessed with fighting that enemy. And in a way, they start acting less like humans, and more like beasts. They act the way frightened herd animals do at the sight of a predator, or the way hungry pack animals do at the sight of prey. They want to join together in unity for a single life-and-death purpose, like hyenas mobbing a wildebeest, or wildebeest stampeding away from hyenas. In order to have that kind of unity, they look to a single decision-making organization to direct the war; they look to the government.
And the more terrifying the threat is, or the more tempting the prize, the more the whole life of the country becomes about the war and comes under the direction of the government. So the more war there is, the greater the power and glory of the government. People in government know this very well. That’s why so many of them love war so much, and work so hard to start wars and to make them bigger. For more on this, see my essay, “The Herd Mind.”
But wars are extremely expensive. All those troops, and guns, and fighter planes, and drones, and bombs have to be paid for. So how to raise the money to pay for them? One way the government does this is through taxes; the government just takes the money from the people. But there’s a major limitation with that; people don’t like being taxed. They’ll tolerate a certain degree of it; and they’ll tolerate more than usual if they’re in that wartime beast-mode. But at a certain point, even the most pig-headed, rah-rah war lover will snap out of beast-mode when he realizes that not only are his sons or his friends’ sons getting hurt and dying, but the government is taxing him and his family into poverty to fund the war. When things reach that point, the people will turn against the war. And if the government doesn’t stop the war and ease up on the taxes, they’ll turn against the government itself.
So the government has a challenge. Is there a way for it to take wealth from the people without them knowing it, and so without them resisting it?
There is, if the government has control over money. It’s called inflation. The government just creates more money for itself that didn’t exist before and uses that money to pay for the war. But how is that “taking” from anybody? It’s easy to see how the government gains by doing that, but does anybody lose anything? Let’s see.
Let’s say I’m the government. I have different departments; they’re all part of me; they’re all part of the same gang. But they each have their different roles. My right hand is the Treasury. It has my main bank account: which is on this notepad. The Treasury includes the IRS, which is this finger. Now I use this finger to poke you guys and demand money. You guys are the taxpayers; the American public. You each have your own bank account, which is on your notepad. When you pay taxes, that money gets crossed off of your notepad, and mine increases by the same amount. Now my right foot is the Department of Defense, or the Pentagon, which runs the military. It’s what I use to go around stomping on townspeople and goat-herders. It has a bank account too, but all its money comes from the Treasury.
Again, as a government, I really like war, because it turns you all into my obedient little beasties. But to have my war, I need my Pentagon right foot to have weapons for it, and that costs money. For example, let’s say my Pentagon foot really wants this fancy-looking new fighter jet called the F-35. It’s a real plane being developed, and it’s a piece of junk. It can’t see where it’s shooting and it can’t fly in the rain. But it’s a fancy piece of junk and I want it. But to get just one F-35, my Pentagon foot needs to pay $200 million to the company that makes it, Lockheed Martin. Who’s good at making paper airplanes and wants to be Lockheed Martin? Okay go ahead and make one and bring it up to the stage along with your notepad and pen.
But the problem is my Treasury doesn’t have $200 million to give the Pentagon to buy it. I could try poking you all with my IRS finger to get you to cough up the $200 mil. But you’re already sick of being poked, and sick of being taxed. I’m afraid if I poke you anymore, you’ll bum rush me, drag me off the stage, and throw me out that window. So let’s say instead, I use my inflation power. My treasury right hand just adds $200 million to my own bank balance. (Now, I know that’s not the way it works in real life, but we’ll get to that.) And voilà, I have $200 million now, because I say so. And I can transfer that to my right foot Pentagon, which can use it to buy an F-35.
I didn’t have to tax you all. So no skin off your back, right? Or is it? Remember, that’s the question. Does anybody lose when the government gains in this magical way? Now, when you think about it, somebody must lose, because it’s not really magic.
The true material wealth of society; what actually sustains human life and makes it more comfortable and delightful, is the stuff we buy with money; not money itself. Its the food, clothing, housing, smartphones, mountain bikes, and other consumers’ goods, plus the farmland, factories, robots, raw materials, and labor and other producers’ goods used to make those consumers’ goods. I covered this point in detail in my inflation talk last year which is on YouTube, and in my essay based on that talk, “How Inflation Drinks Your Milkshake.”
Creating new money doesn’t create any additional stuff to go around. So if creating money got the government more stuff, that means other people must have less stuff. It’s a zero-sum game; a win-lose situation. If the government wins something through inflation, somebody has to lose. So who loses?
One definite loser is whoever would have acquired the F-35 otherwise. Now flying killing machines generally don’t have a lot of buyers outside of government. So if the Treasury hadn’t been able to buy it, the highest bidder for the F-35 might have been a scrapyard: just as it should be. The scrapyard would have bought it, dismantled it, and sold its parts and materials for peaceful purposes.
So the scrapyard lost while the government gained. But the government isn’t the only one who gained from the inflation. Who else gained? Lockheed Martin, because its selling price was bid up way higher than the scrapyard would have paid. And then who else gains by Lockheed Martin having more money to spend? Lockheed Martin’s workers and suppliers, because their selling prices get bid up too.
Does that mean that as the new money filters through society, everybody’s selling prices get bid up? Yes, that’s other definition of inflation: the general rise in prices caused by creating new money. But does that make everybody richer? Again, that’s impossible, because again, that would mean more stuff had been created, when it wasn’t.
You see, the new money reaches some people early and some people late. By the time the new money reaches the late receivers, bidding up their selling prices, it has already bid up the prices of the things they buy even more. So the late receivers get poorer, while the early receivers get richer.
And the earliest receivers always include the government and its contractors, including especially the companies in what President Eisenhower called the “military industrial complex,” while the late receivers are usually honest working people who don’t have lofty government connections. So these honest working stiffs are effectively taxed, for the sake of the war, and for the benefit of the government and its buddies.
But the people don’t realize that. They know they’re poorer, but they don’t know why. They never saw a tax bill. They never had to cut a check. They just see their wages and revenue not keeping pace with the rising cost of living and cost of doing business, and as a result, they see their ability to get actual stuff get smaller. But they don’t see the government’s role in making that happen, or how the government and its cronies benefit from all that freed up stuff going to its wars instead. But that’s what’s happening. As Eisenhower said in a speech:
“Every gun that is made, every warship launched, every rocket fired signifies, in the final sense, a theft from those who hunger and are not fed, those who are cold and are not clothed. This world in arms is not spending money alone. It is spending the sweat of its laborers, the genius of its scientists, the hopes of its children. The cost of one modern heavy bomber is this: a modern brick school in more than 30 cities. It is two electric power plants, each serving a town of 60,000 population. It is two fine, fully equipped hospitals. It is some fifty miles of concrete pavement. We pay for a single fighter with a half-million bushels of wheat. We pay for a single destroyer with new homes that could have housed more than 8,000 people. . . . This is not a way of life at all, in any true sense. Under the cloud of threatening war, it is humanity hanging from a cross of iron.”
And this is true no matter how government wars are financed.
So, instead of obnoxiously demanding that the public hand over its wealth in the form of taxes, the government just quietly siphons it away through inflation. This way it avoids public outrage and resistance, and so it is able to take far more wealth from the people for its wars.
Pretty sneaky, right? Well, not quite sneaky enough, actually. Because even with this roundabout way of taking people’s wealth, some victims would catch on if the government simply kept adding new money to its own account. Even if people don’t realize how they are losing, they can see that the government is obviously gaining, and that can look pretty suspicious. But the government has a way of even making that unclear. It does so with the help of three new factors: private bankers, government debt, and the Fed.
Now let’s say instead of the Treasury creating the $200 million for the fighter plane, it borrows it from a banker. Who wants to be a corrupt banker? Bring up your notepad and a pen. And we’re starting over, so Lockheed Martin make a new paper airplane. Okay, now I, the government, am broke right now. You are an investment banker at Goldman Sachs, and you have $200 million to invest. Let’s see if, working together, we can inflate, and both come out richer with a stroke of a pen, without it being clear that we did.
Okay, so my Treasury right hand writes on this post-it: IOU $200 million. That’s called a bond: actually a whole bunch of bonds. Now $200 million transfers from your account to mine. And in return, I give you this transferable IOU bond which gives you (or whoever buys it from you) the right to collect $200 million from me later, plus interest. Now, I transfer the $200 million to the Pentagon, which it pays to Lockheed Martin for the F-35. I have my shiny new plane, but I also owe $200 million plus interest.
But that’s when my left hand finally comes into play. My left hand is the Federal Reserve, or the Fed. In the US government’s real-life arrangement, it’s the Fed, not the Treasury, that has the power to create new money.
The Fed says: “Hey everybody, I just so happen to be interested in buying government debt. Anybody selling? Ah, Mr. Goldman Sachs person; you have $200 million in Treasury bonds, eh? I’ll pay you $205 million for them, which will be a nice profit for you.”
So the bonds go to the Fed. But of course the Fed has its peculiar way of paying for them. I just reach over with my left hand and write directly on Goldman Sachs’s notepad: 205 followed by 6 zeroes. The Fed just credits Goldman Sachs’s account $205 million, creating the money out of thin air.
Now let’s review. What were our benefits? Goldman Sachs has $5 million more and my Pentagon has a shiny new fighter plane. And what are our costs? The Fed has $200 million in Treasury IOUs, and that means the Treasury now owes the Fed $200 million plus interest. My right hand owes my left hand some money. But it’s all just me, the government. I didn’t give up anything. There are no costs for the government or its buddies. The inflation simply made us richer at the expense of the public, just like it did in the simpler example.
But to the average observer it’s not clear that it did, because of the little shell game I just played. People think: “Oh the Treasury’s not really just getting something out of nothing. It’s borrowing, and it’ll have to pay it back. And Goldman Sachs is getting new money, but that’s not for nothing either, because it’s selling a bond. And the Fed is doing the money creation, but that’s not going directly to government spending. It’s just compensating Goldman Sachs for its investment, and it’s also stabilizing the price level and keeping unemployment low. And it’s all very complicated and technical. But they’re experts, and they’re just looking out for us.” You see how tricky they are?
And it’s even worse than that. Government debt helps the government secretly enrich itself to finance war in another way. Inflation also involves a transfer of wealth from savers to borrowers. When prices go up, the money your grandma has saved for her retirement doesn’t buy as much stuff. At the same time, the government’s debt burden is lightened because as prices rise, so does nominal tax revenue, while the amount of debt doesn’t change. This is another quiet transfer of wealth to the government.
There’s yet another way inflation masks the costs of war. Inflation causes the boom/bust cycle. Since governments inflate when they go to war, there is often an economic boom at the beginning of the war. So not only do the people not know who’s making them poorer, they don’t even think they’re poorer in the first place, because of the boom; in fact they think they’re richer.
This causes them to squander resources, as Jonathan Newman will explain, which only adds to the waste of sending men and resources off to be blown up in another country. Eventually, the inevitable bust comes. But often this doesn’t come until after the war, as the familiar post-war depression sets in. This correlation promotes the myth that wars are actually good for the economy, which makes it even easier for governments to wage them.
Thanks to inflation, the US government can take wealth to its heart’s content to fund huge and endless wars and a globe-spanning empire.
And that’s exactly what’s happened since the creation of the Federal Reserve in 1913. Governments meddled with money to support their wars long before central banks like the Fed. The Roman emperors did it; the medieval kings did it. But to the extent the people had sound money (gold and silver) there was always a check on that. Sure you can clip and debase coins. But you can’t conjure them out of thin air. It was with the rise of central banking that the government’s ability to finance war with inflation really took off.
That is why in his book End the Fed, Ron Paul wrote: “It is no coincidence that the century of total war coincided with the century of central banking.” By total war, he meant the nearly complete mobilization of an entire country’s labor and resources into an engine of industrial-scale murder and destruction. As Lew Rockwell wrote: “The story of central banking is one step
removed from the story of atom bombs and death camps.”
Without central banking, World War I as we knew it would have been impossible. And World War I was one of the worst disasters in history. It ended a century of relative peace, freedom, and rapid economic progress. It introduced to the world total war on a scale never seen before. And it led to the rise of Fascism, Nazism, Communism, and the permanent establishment of Progressive statism. In particular the creation of the Fed in 1913 made US entry into World War I possible, which made the disaster even worse by making the subsequent peace totally one-sided and giving the western powers a globe-spanning empire.
Central banking caused the German hyperinflation which helped lead to Hitler. It caused the boom that went bust in the 1929 crash, which led to the breakdown of international trade relations, which helped lead to World War II. It funded US entry into World War II, which permanently foisted on America a national security state and established Washington as the imperial capital of the whole world. Along with that empire came monetary imperialism; after World War II, America used its military dominance to export its inflation and to extend its inflation tax across the globe. So inflation promotes war and empire, which returns the favor by promoting inflation.
Now America’s money machine supports over 700 foreign bases around the world, and a global network of mass surveillance, CIA & NGO destabilization missions, drone campaigns, and special forces deployments. It holds nearly every country in the “free world” in its thrall. It props up and arms brutal military dictators, royal despots, and occupying armies in the Middle East, which along with our wars promotes terrorism. Since the end of World War II, it has enabled the US to launch 201 out of the 248 armed conflicts in the world and to bomb, sabotage, or attempt to overthrow governments in China beginning in 1945, Syria in 1949, Korea in 1950, Iran in 1953, Guatemala in 1954, Tibet in 1955, Indonesia in 1958, Cuba in 1959, Congo in 1960, Iraq in 1960, Dominican Republic in 1961, Vietnam in 1961, Brazil in 1964, Belgian Congo in 1964, Laos in 1964, Dominican Republic in 1965, Peru in 1965, Greece in 1967, Guatemala in 1967, Cambodia in 1969, Chile in 1970, Argentina in 1976, Turkey in 1980, Poland in 1980, Cambodia in 1980, Angola in 1980, El Salvador in 1981, Nicaragua in 1981, Lebanon in 1982, Grenada in 1983, Philippines in 1986, Libya in 1986, Iran in 1987, Libya in 1989, Panama in 1989, Iraq in 1991, Kuwait in 1991, Somalia in 1992, Iraq in 1992, Bosnia in 1995, Iran in 1998, Sudan in 1998, Afghanistan in 1998, Yugoslavia-Serbia in 1999, Afghanistan in 2001, Iraq in 2003, Somalia in 2006, Iran in 2005, Libya in 2011, Syria in 2011, and Ukraine in 2014.
It was while looking back at World War I that Randolph Bourne concluded that, “War is the health of the State.” And around the same time, it was while looking back at that same war from the other side that Ludwig von Mises wrote: “…inflation is an indispensable means of militarism.”
In other words, war is the health of the state, and unsound money is the health of war.
Also published at Medium.com.
Thank you for reading. I work at the Mises Institute where I run the Mises Academy, an e-learning program for Austrian economics and libertarian political philosophy. I am a columnist for Antiwar.com and my essays have appeared at Mises.org, LewRockwell.com, The Ron Paul Institute, and David Stockman’s Contra Corner. I have given lectures and conducted interviews for the Mises Institute and appeared on The Scott Horton Show and The Tom Woods Show. You can find all of my essays, lectures, and interviews at DanSanchez.me, you can follow me via Twitter, Facebook, TinyLetter, and Medium, and you can email me at dan-at-mises.org.